For Monday, August 6, 2012, We Recommend Against Investing

August 3, 2012

We recommend selling your equity positions or hedging for a risk-neutral position.

Technical Comment:

The S&P 500 advanced 1.9% Friday with volume below Thursday but above the 30-day moving average volume. The S&P 500 would have to decline about 3.6% (-50 points) on Monday to change our automated forecast to an uncertain trend.

Subjective Comment:

The advance on Friday can be considered a strong-volume up-day, and very interestingly a pattern that predicts market growth occurred as a result of the large index advance on the S&P 500. The pattern is one of the less common patterns our automated algorithm is designed to detect, but it did indeed occur. Subjectively we remain very concerned about the US money supply growth rate, so it is difficult for us to recommend following the predictive pattern identified by our technical analysis.

Speculation continues regarding the European Central Bank’s recent monetary policy announcements regarding the buying of European Sovereign bonds. Italy’s and Spain’s 2-year bonds increased in price, pushing yields down. However, their longer-term debt yields remained above 7%. Why would the short-term debt of these nations suddenly increase in price? Supply and demand suggests because of sudden, large demand in the purchasing of these bonds. (Demand goes up, so price goes up because there was no new supply provided.) If the ECB was not directly buying this debt, who was? Our best guess would be European banks. We recall that the ECB recently reduced the interest paid on excess reserves to 0%, so European banks have an incentive to seek a return on their cash now that the ECB is not providing any on over 800 Billion Euros. That’s plenty of cash that European Banks could be using to purchase Spanish and Italian short-term debt. We also think the ECB’s 2-year Long Term Refinancing Operations (LTRO) from earlier this year influence these debt purchases. If it was European Banks purchasing this debt on Friday, the maturity horizon is still within the LTRO repayment date. This is why we think the likely buyers were European Banks. Why they bought is the question of much speculation. Some think it means the ECB will be printing Euros very rapidly and very soon, so the European Banks are starting to buy this debt now so they can sell it to the ECB in the near future for a profit. It’s also interesting to note that some German Politicians have signaled they would not oppose bond-buying by the ECB. Does this mean the ECB will launch a Quantitative Easing program in the near future? Anything is possible. Remember, central bankers will say things to try and get the market and economy to grow in reaction to their comments. This can have a short term impact on markets, but it will take actual money printing to delay the business cycle crash that is coming in Europe, China and the US. If the ECB starts printing, European markets would likely rally, causing a spill-over impact on US markets. Any impact on US markets will be short lived if the Fed continues it’s very slow growth of the US money supply.

The large index advance of 1.9% on Friday pushed the S&P 500 to where it was 3 months ago. The single day advance of 1.9% is a lot to be sure. Regardless, without an acceleration of the US money supply, US markets will decline even though there will be up-days along the way. We discussed the details of the US money supply in detail in our previous post which we encourage you to read if you missed it. Continue to hold and accumulate cash. Stay out of US equities and all bonds. Hold your price inflation hedges for the long term. Be prepared to change your investment portfolio allocation if things change. The technical pattern formation and the sharp decline in short-term Spanish and Italian debt is very interesting information. We will be watching for additional data suggesting an up-trend could be forming. However, we will need to see US M2 rapid growth before we change our subjective “risk-off” recommendation.

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